Market power
[1] In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing revenue.
[2] This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output.
The size of the gap, which encapsulates the firm's level of market dominance, is determined by the residual demand curve's form.
The decrease in supply creates an economic deadweight loss (DWL) and a decline in consumer surplus.
[5] This is viewed as socially undesirable and has implications for welfare and resource allocation as larger firms with high markups negatively effect labour markets by providing lower wages.
[5] Perfectly competitive markets do not exhibit such issues as firms set prices that reflect costs, which is to the benefit of the customer.
As a result, many countries have antitrust or other legislation intended to limit the ability of firms to accrue market power.
[6] As a result, legislation recognises that firms with market power can, in some circumstances, damage the competitive process.
[4] An example of which was seen in 2007, when British Airways was found to have colluded with Virgin Atlantic between 2004 and 2006, increasing their surcharges per ticket from £5 to £60.
[8] Regulators are able to assess the level of market power and dominance a firm has and measure competition through the use of several tools and indicators.
[10] "Perfect Competition" refers to a market structure that is devoid of any barriers or interference and describes those marketplaces where neither corporations nor consumers are powerful enough to affect pricing.
A perfectly competitive market is logically impossible to achieve in a real world scenario as it embodies contradiction in itself and therefore is considered an idealised framework by economists.
[15] Monopolistic competition is a type of market structure defined by many producers that are competing against each other by selling similar goods which are differentiated, thus are not perfect substitutes.
[19] All of these treatments have one unifying factor which is the ability to influence the market price by altering the supply of the good or service through its own production decisions.
A monopoly is considered a 'market failure' and consists of one firm that produces a unique product or service without close substitutes.
The graph below depicts the kinked demand curve hypothesis which was proposed by Paul Sweezy who was an American economist.
[30] An oligopoly may engage in collusion, either tacit or overt to exercise market power and manipulate prices to control demand and revenue for a collection of firms.
An advantage of using concentration as an empirical tool to quantify market power is the requirement of only needing revenue data of firms which results in the corresponding disadvantage of the inconsideration of costs or profits.
An advantage of concentration ratios as an empirical tool for studying market power is that it requires only data on revenues and is thus easy to compute.
[22] The Lerner index is a widely accepted and applied method of estimating market power in a monopoly.
[41] Lerner (1934) believes that market power is the monopoly manufacturers' ability to raise prices above their marginal cost.
The formula focuses on the nature of monopoly and emphasising welfare economic implications of the Pareto optimal principle.
[43] Although Lerner is usually credited for the price/cost margin index, the generalized version was fully derived prior to WWII by Italian neoclassical economist, Luigi Amaroso.
[47] Consequently, the relationship between market power and the price elasticity of demand (PED) can be summarised by the equation: The ratio
